Early Retirement : How to Maximize Your Wealth and Minimize Your Taxes

Tax Savings Strategies for Early Retirees

In this episode of The Retire Early Retire Now podcast, host Hunter Kelly delves into tax-saving strategies tailored for high-income earners aiming for early retirement. Hunter discusses the advantages of Roth conversions during low-income years, the benefits of tax-loss harvesting to offset capital gains, the importance of proper asset location, strategic withdrawal sequencing to minimize taxes, and the utilization of Health Savings Accounts (HSAs) for managing medical expenses before Medicare eligibility. Emphasizing long-term tax planning, he offers valuable insights to help listeners retain more of their wealth and achieve a smoother transition into early retirement.

00:00 Introduction to Tax Savings Strategies for Early Retirees

02:25 Roth Conversions: A Game Changer for Early Retirees

09:22 Tax Loss Harvesting: Turning Losses into Gains

14:09 Asset Location: Placing Investments Strategically

17:21 Strategic Withdrawal Sequencing: Maximizing Your Retirement Funds

20:05 Health Savings Accounts: A Triple Tax Advantage

22:40 Conclusion and Next Steps

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Transcript

0:00

Welcome back to The Retire Early Retire Now podcast. The podcast where we dive deep into all strategies that will help you achieve financial freedom sooner, live better, and take control of your retirement. I'm your host, hunter Kelly, and today we're talking about tax savings strategies for early retirees that help minimize their tax burden. And if you're dreaming of an early retirement, and you're a high income earner. This episode is for you. So the last few episodes we've been talking about, kind of accumulation phase, leading up to retirement, what type of planning we should do. And so over the next few weeks we're going to talk about that transition into retirement. one from a tax saving strategy standpoint. what happens to your social security? and then talk about withdrawals as well. So stay tuned for this episode, obviously, and then the following, episodes here, in the next coming weeks as well. And so I've been receiving, some more and more five star reviews. So for those that are leaving those five star reviews, I just wanna say thank you very much. It's helping this podcast grow. and you, if you're continuing to enjoy this share, share it with a friend. and if you have not left a five star review, go ahead and do that. If you're liking this podcast, so now taxes can feel like a huge roadblock when you're planning for your early retirement, especially if you're a high income earner. But trust me, it doesn't have to be that way. With the right strategies in place, you can. Take advantage of the tax code to keep more of your money in your pocket and away from Uncle Sam. So if you've been following along with the podcast, you know, we love actionable real world strategies that we'll talk about in today's podcast episode. And just like some strategies that we've talked about previously,'cause we wanna put this into action. Now what we really won't get into today is developing a personalized plan. we don't really do that here. We don't give advice. We're just here for education. So if you think one of these strategies would apply for you, reach out to a professional. we at Palm Valley Wealth Management would love to work with you. You can go to my website, palm valley wm.com, and we can put a plan together to help, lessen your tax burden over time. and. Do various other things as well. So whether you're grabbing a cup of coffee, you're driving to work, sitting at a beach somewhere, hope you enjoy this episode and let's get into it. So the first thing that we'll talk about today and one of the best, or what I think is the best, tax saving strategy is. Roth conversions in early retirement, for those low income years. So first up again is Roth conversions. This strategy can be an absolute game changer. it can save you potentially hundreds of thousands of dollars in taxes depending on your situation. so why not? Keep that money in your pocket, keep it invested so that you can grow your net, net worth more. Not so you can pass away and leave everything to all of your kids, but so you can enjoy that money while you're living. Whether that's taking care of your kids, going on trips, traveling, Doing different hobbies, whatever that may be for you. this is what this podcast is about, so let's keep that money in your pocket. And so if you've been putting away, in your tax deferred accounts like 4 0 1 Ks, traditional IRAs, 4 57 bs, whatever that may be for you, during your high income earning years, you're, you're probably going to face a huge tax bill once you start taking distributions, especially once you hit. Age 75, where you have to start taking RMD. So this is where tax planning really comes into play and not just filing your tax return each year and trying to minimize in that given year. If you start thinking 5, 10, 15, 20 years out, you can really start to use things like Roth conversions to save taxes, a lot of taxes. Over time. So what's the solution? Converting some of that money into, Roth IRA before. you retire or early on in retirement can be a huge benefit later on, later on in your, retirement because now you can reduce that burden of RMDs, reduce the burden of having to take distributions off of, those pre-taxed accounts. So the beauty of this strategy is that during. Your early retirement years, you might be in a low income bracket, so you might be, you might not be taking Social Security yet. You might not have your pension. If you're lucky enough to have one, you may be using cash that you saved up or have a brokerage account, On paper, your income is going to look low. So this can be perfect opportunity to convert those traditional or those pre-tax funds to your Roth IRA, because you'll be taxed at a lower rate. So hopefully when you were working, you were deferring a very high tax rate, 30 plus percent, whatever that may be for you. and now because you're retired and you're using sources. Of income that don't necessarily generate income on your tax return, you can start to convert at a much lower rate. So plus, once the funds are in your Roth, IRA, they start to grow tax free. they'll be tax free as well once you take those withdrawals. So that's the beauty in a Roth IRA. Right? And so unlike a traditional IRA Roth, IRA has no. Require minimum distribution. So the more that you can get in here, within reason without, spiking taxes too high, which we'll talk about here in just a second, the more you can get in there, the less you'll have to worry about being forced to withdraw that later on when you hit age 75. let's say you're. You retire at 55, you have a gap between now and age 75 when you start taking Social Security or age 70 when you start taking Social Security. So those 15 years could be a prime time for rock conversion. Not saying you have to take Social Security at age 70, but if you situation calls for it, if you wanna delay it. to improve your social security payment, or it just makes sense based off health and things of that nature. You could have potentially 15 years of Roth conversions without having that extra income on your tax return. So your taxable income might be low. I. And this gives you great opportunity to convert, some of that traditional IRA money to Roth at a much lower tax rate that we've been talking about. So you'll pay taxes on that conversion. so if you convert 50,000, a hundred thousand, whatever that may be, that will count toward your ordinary income. so you'll pay taxes now, but it could be totally worth it in the long term, avoiding higher taxes later on down the road once you're. In your sixties or seventies because of the RMDs, that you'll need to take or just distributions in general to support your lifestyle, but don't go overboard with the conversions. Okay? These conversions are a lot like a bell curve. so when I start running these projections for clients, we'll say, okay, we want to, we want to convert. This amount or that amount. And so what you'll see is as you start to convert, if the strategy makes sense for that in particular client, you'll see the tax savings start to increase. And because of that, that money stays invested and they'll, their net worth will start to increase. But as you start converting more and more and more. You may see that bell curve, where now, the sweet spot was maybe at a hundred thousand dollars a year that we convert from pre-tax to Roth. And we just start running those projections and let's say, oh, we wanna do$200,000 a year. Well now that. that conversion may, bring on too many taxes up front and the juice may not be worth the squeeze. So you really wanna run these projections and understand what you're doing as far as from a tax standpoint of, am I paying too much taxes up front? what does that look like long term? And so generally. Speaking, you want to flatten out that tax bill over your lifetime because what will happen if you don't do the conversion is yeah, you'll have low taxes for, call it five, ten, fifteen years potentially. but then once those RMDs kick in, or you run out of that tax, taxable account, you run outta cash and you have to start taking withdrawals from your IRAs or 4 0 1 Ks is now that. that income bracket will spike, right? And so that spike may cause more taxes over your lifetime than smoothing that out because you've been taking, Roth conversions over that 10, 15, 20 years, whatever that may be for you, right? And so we really wanna be able to run these projections. We want to, consider, Medicare as well. So if you're doing these conversions and then you turn 65. that that could increase your Medicare cost. So what is that gonna do? you just have to factor in those types of things. there's a lot that goes into it, but if you are able to convert at a lower rate, you have the ability to potentially save, quite a bit of taxes. it's not unheard to see, saving over six figures in taxes over your lifetime, which can result in a much higher net worth over time. Number two, strategy is my second favorite, and that is tax loss harvesting. This is something you can do, uh, throughout your financial journey, whether you're starting out or you're in retirement, whatever that may be. you can do this, pretty much anytime, but tax off servicing again can be a great. Strategy to help you minimize taxes over your lifetime. So if you've been investing for a while, you probably know, not every investment is going to be a winner, right? So just'cause Apple is up 50% this year, doesn't mean Google is too, right? they do kind of correlate sometimes, but sometimes. they don't. Right? And so the good news is that you can use those losers to offset gains and reduce taxable income. So here's how tax loss service harvesting works. We've talked about it and a few other podcasts we haven't talked about in a while. If you sell those investments that are down, so they're at a loss, and you realize that loss, this can offset any capital gains you've made from other investments. So using the Google and Apple, right. If Apple is up, Google is down at a loss. You sell Google, you either hold it in cash for 30 days, or you buy a different investment and you lock in that loss on paper. as a disclosure, you wanna make sure that you avoid those wash sale rules. if you. Sell Google and then buy it right back the next day. the government's gonna go, no, you can't do that. Right? So, uh, we wanna make sure that we're, aware of those wash out rules and avoid those so that we can capture these losses. But if you capture that loss of Google and you sell Apple at a gain, you can use that loss to offset. Right? So let's say you've had some big. gains in your stocks, but you also have some investments that are down. You may, you can sell again. Those at a loss, those losers at a loss reduce your tax bill, and will make you more profitable over time. So you can even use up to$3,000 of losses to offset ordinary income each year. And let's say you don't have enough gains to, offset all of your losses, you can carry those losses forward, for as long as it takes to use them up. So, especially early on in your investing. Journey if you were able to capture quite a bit of losses. So I had a client, come to me early this year. They had a lump sum of cash, that they wanted to invest, bad timing from a market perspective, or market performance perspective. so obviously the market pulled back because of tariffs and all that fun stuff that we experienced over the last few months. And the good news is that we were able to capture, About 80 to a hundred thousand dollars worth of losses in their account that they're gonna be able to use. And move forward. Now, their account, because of the way they are allocated, is close to recovering already, right? And so, it's, they're basically breaking even. They have all these losses and as the market continues to run back up, they're going to be able to use those over time to offset any gains. And they happen to own a business and, and some other stuff. they'll be able to really use those strategically, for their situation. And another example, another real world example. So for example, if you've made$10,000 in capital gains from selling a stock, but you've lost 10,000 in another investment, you can sell the losing position to wipe out the gain even better, you can use up to$3,000 to reduce your taxable income. This strategy is a great way to lower your tax bill, right? So if you've accumulated losses, over time and you. Happen to retire before you use all those losses. Well, early on in retirement, you may able to use your taxable account, for income. And because of those losses, you'll essentially be tax free, on those particular investments, right, until you, you lose or you use up all those losses. this can be a great. Way to one, boost your performance in your, taxable accounts because, your tax drag is minimized because you're using one of these, tax saving strategies, but then also you can use those losses later on down the road, to potentially, not pay as many taxes in retirement. Right? Number three is one that is not talked about a lot, especially if you're not a financial advisor. So a lot of, Let's just say, financial education. People that aren't licensed and don't actually practice wealth management, oftentimes they will miss this. And I'm not saying everybody, but this is something that's not talked about a lot, and that is asset location. So putting the right investment in the right accounts. Now let's talk about something that doesn't get enough attention. like I said, asset location, this is all about putting the right types of investments in the right type of accounts. So in other words, taxable investments go in taxable accounts, tax deferred or tax free investments like IRAs and Roth IRAs. Where do I put my investments? How do I do that? how much should be in which, as far as percentage wise, and what type of investments, stocks, bonds, mutual funds. Whatever that may be. where does it all go and how can I make it most efficient? So different types of investments are taxed differently. For example, bonds or bond funds produce interest income, which is taxed at ordinary income rates, so it makes sense to hold bonds and tax deferred accounts like 4 0 1 Ks, like IRAs, where you don't have to worry about paying taxes each year. So. If you feel that your overall allocation needs fixed income, well, a good place to have that fixed income is in these accounts that are tax deferred so that you can receive all of that interest income and not have to worry about ta that tax drag on that money each year. So that being said, in your Roth accounts, in your taxable accounts, you'll want more growth heavy. type investments that do not produce, income driven investments. Right? Uh, because you would have to worry about that each year. You would have a tax bill on that each year. And so, again, on the other hand, stocks, are tax more favorable, whether it's long term or short term. So generally long term gains if you're holding it longer than a year, which could be 0% if you play your cards right, 15% or 20% depending on your income. So it makes sense to hold stocks. in your taxable account or in your Roth account, because it's a more long-term play and you're never gonna pay taxes on that again in your Roth, where long-term capital gains would apply in your taxable accounts. and so you can stash them in your Roth as well, like I just said. So the goal here is to minimize your tax drag. That's all we're trying to do here. So if we look at our three buckets, we have cash. We have our Roth and we have, our pre-taxed. so if we look at our buckets here, we have our taxable account, we have our tax deferred or pre-taxed accounts, and then we have our Roth. And so we really wanna try to, make that ratio, minimize our tax drag as much as possible over time. So if you're, when you're structuring your portfolio, think about the best way. To create that tax efficiency, place your investments to generate ordinary income in your tax deferred accounts, your growth oriented investment accounts or investments in your taxable accounts. this way, you can get the most bang for your buck. so again. This is a very personalized, strategy. so if you're confused on how it works and how much you should have in each, it depends on when you're retiring, what your income looks like, things of that nature. please seek professional help. And again, we would love to help you at Palm Valley Wealth Management. number four, strategic withdrawal sequencing. So again, you're retiring early. Let's say you're retiring at 50 to 55, your sequence of withdrawals are gonna look different from someone retiring at 65, right? So when it comes to early retirement, how you withdraw your money is just as important how you save it, because the last thing you wanna do is climb up Mount Everest and then not make it back down, right? So the order in which you pull your money from different accounts can make a huge difference in how you pay tax. So the basic idea is to tap into your taxable accounts first. Then your tax deferred accounts like traditional IRAs, 4 0 1 Ks, things of that nature, and then leave your Roth for last. This allows your Roth to keep growing tax free as long as possible, and it keeps the taxable income lower in your early years so that you can do those things like. Roth conversions. So real world experience. Let's say you're retired and you need to take$50,000 a year out for living expenses. If you start by taking$50,000 out of your taxable account, you may owe capital gains on that money, and if you've played your cars right. If your, income is below the threshold, you may pay 0% capital gains on that money. Or let's say you aren't lucky enough and your income is exceeding those thresholds where now you're paying capital gains tax, that capital gains tax is likely still more favorable than your ordinary income that you would. Receive from a traditional IRA, things of that nature. you want to be strategic about this. If you can get those capital gains down to zero, certainly play that game. and that's something we can talk about in a later podcast if that's something you want to hear. So let me know. I would love to, to know exactly what you want to hear. And I'll talk about those, things as well. But, so taxable or capital gain rates are gonna be more favorable than ordinary income. And if you're retiring early, you're gonna have that ordinary income, potentially plus a penalty. You can do things like 72 t or the rule of 55, but there's just more. hoops to jump through and things of that nature. So using that taxable account early on is usually best because of Roth conversions and, capital gains rates being more favorable. so let's jump into number five. and that is going to be something that may be overlooked, but it's uber important to, or retiring early, and it's the thing that prevents. Retirees or potential early retirees from retiring, early. And that is health insurance and health insurance costs and things of that nature. So utilizing your HSA is very important, for a number of reasons. And so if you have access to a HSA and you're sitting, you're sitting on a triple tax advantage, account, right? So the contributions go in tax deductible. They grow tax free if you're at Fidelity. Or another brokerage where you could invest that money. And then the withdrawals for medical expenses are tax free. So if you're a high income earner, one of the strategies that you could utilize, to help with health care costs in retirement before you get to Medicare is, okay, well maybe I cash flow a number of years of my health insurance costs. Knowing that I'm putting into this HSA to get the tax benefits, and we can, keep record of all of our medi, medical costs. So let's say you rack up tens of thousands of dollars in medical bills over a number of years, well then now you can start taking that money out in retirement to maybe supplement those premiums that you will be getting paid because you've already accumulated that cost. You can take those out, those. those dollars out that you paid for medical cost, even if it's 10 years ago, as long as you have record of it, in case you could audit it, whatever that case may be there. but you can take that money out and now you can supplement. Some of that cost from the premium of that private health insurance. And then you also still have that money there for your deductibles, your co-insurance copays, all the things that are associated with medical costs, right? And so that can supplement all the way until you get to Medicare. And let's say you get to Medicare age and you're 65 and you still have a fair amount of money left in there, you can actually take that money out. Regardless of Medicare medical cost or not, as a retirement account. So you would just pay your income taxes on that. You wouldn't get that tax free distribution, but you would continue to get that deferred growth, and be able to use that for retirement as well. that is the one thing that people often get hung up on with retiring early is health insurance. And one way to plan for that. Is, go ahead and get that deduction. Contribute to that HSA, save that money, cash flow, your medical cost upfront if you can. And start to save, that money in that HSA so you can help pay for premiums with the money that you're allotted to take out because of those medical expenses. Um, and then all of that growth, can be used to pay for out-of-pocket maxes and copays and, and all those things that we just talked about. great strategy there. And so that is the final. tax saving strategy for us. So again, we talked about Roth conversions, talked about tax loss, harvesting, asset location, strategic withdrawal, sequencing. Basically, how are we gonna take off this money without running outta money? and then lastly, HSA. And so again, these are just strategies that we talked about and, a couple of different ways. putting all of these together is sometimes very difficult and overwhelming. That is what I do at Palm Valley Wealth Management is I work with clients to help them with tax planning and other things like investment planning, retirement planning, to take care of their overall situation so that they can retire early. That is the whole goal of my practice. That is a whole goal of this podcast to help people get educated so that they can make sound decisions. And retire early. So if you're struggling with that, you don't know how that works and or you don't have the time or maybe even the desire to do that, please reach out via my website, Palm Valley wm.com. You can check me out, you can schedule a call, first calls, no cost to you. We can just get to know each other, and see if it's worth working together and, see how I can help you. But, Yeah. thanks for listening. If you like this podcast, share it with a friend and leave a five star review on your favorite podcasting app. And I look forward to next week where we talk about how social security works with an early retirement. And then the following week we'll start talking about withdrawals and retirement. we'll see you in the next one. This podcast is for educational purposes only. It is not meant to be financial or. Legal or tax advice do not make decisions. Based off of this podcast alone. Please seek professional help. when you start making decisions about your personal situation. Please keep Palm Valley wealth management in mind when making those considerations. I.